What is Angel Tax?

Without question, India has led the world in recent years in terms of fostering prosperous business prospects. The global investor community, comprising high-net-worth individuals (HNIs), foreign funds, venture capitalists, angel investors, and others, remains optimistic about the growth prospects presented by the rapidly expanding Indian startup landscape. 

Despite the support of government initiatives such as Startup India, Stand-up India, and Digital India, the term “Angel Tax” remains a significant concern for the Indian startup community. In an effort to bring about change, the CBDT recently froze income tax under section 68 from the bank accounts of certain firms due to inaccuracies in cash credits made to those accounts.

The subsequent sections will delve into the meaning of angel tax and explore the Angel Tax Exemption, applicability, drawbacks etc., within the Indian startup community.

What do you mean by angel tax?

So, what is angel tax? Every firm requires money to run an early-stage enterprise. In this scenario, companies lack tangible assets for collateral, leading them to seek funding in exchange for equity. Angel investors are likely to invest in startups facing challenges in gaining traction in the market.

The concept of angel tax is present in Section 56(2) (viib) of the Income Tax Act of 1961. As per the Finance Act of 2012, unlisted startups (those whose shares are not publicly traded on the stock market) receiving investment from angel investors are mandated by the Income Tax Act to allocate a specified portion of their contributions to the government. But if the entire investment is worth above the company’s FMV or fair market value, then this tax becomes applicable. An investment that exceeds fair market value (FMV) is popular as “income from other sources” and is subject to an angel tax. 

To thoroughly comprehend the angel tax notion, let’s look at an example. Imagine your company obtains a Rs. 15 crore investment from an angel investor in return for shares. However, the issued shares have a total fair market value (FMV) of Rs 10 crore. The remaining Rs 5 crore is subject to a 30.9% tax rate if it is deemed surplus money. 

This tax’s main goal was to avoid problems with money laundering. The real percentage of people who comply with tax rules is about 2%. The majority of startup companies fail to maintain the proper accounting records or accurately list their assets, which contributes to the production of black money in India. The Income charge department chose to charge the private corporations on excessive share premiums obtained over the FMV as a result of this fault.

What are the changes in angel tax for Budget 2023?

According to Budget 2023, shares issued to non-resident investors over FMV will be subject to the taxability clause. Furthermore, non-resident investors are currently not eligible to receive the exemption from the “Angel Tax” that is granted to domestic investors in qualifying startups.

What are angel tax exemptions?

Prior to this, section 56(2)(viib) under the heading “Income From Other Sources” applied to the consideration received in the form of angel investment. To promote ease of doing business, the Indian government did, however, introduce Angel Tax Exemption for startups in 2019. Angel tax is no longer applicable to startups, provided that they meet the following requirements:

1. The startup ought to be acknowledged by the Department for Promotion of Industry and Internal Trade (DPIIT).
2. The startup’s total paid-up capital must be less than or equivalent to 25 crores. Nevertheless, the consideration for shares granted to a venture capital fund, a venture capital company, or a non-resident should not be included in the computation of the paid-up capital.
3. The startup has to be valued, and a certified merchant valuer determines its fair market worth.
4. Foreign investors, not local ones, must provide angel funding for the firm.
5. During the seven years following the share issuance, the startup shall not make any of the following investments:

• Building or land
• Advancing loans
• Capital contribution to any other entity
• Any mode of transport costing more than ten lakhs
• Jewellery
• Archaeological collections and Shares and securities.

Drawbacks of angel tax

Here are a few of the main disadvantages of the angel tax India:

1. Startups that get funding from an Indian resident are subject to the angel tax.
2. A business that receives venture money and investments from non-resident investors is not qualified to deduct angel tax India.
3. Because angel tax forces them to contribute a large portion of the investment, startups typically lose a large amount of money in taxes.

Angel tax rate in India

India’s tax system infrastructure helps employ both progressive and proportional taxation. It acts on the basis of various criteria and income levels. Angel tax is applicable at a steep rate of 30.9% in this country on startup investments that are more than their fair market worth. When a new company approaches investors for investment, it has to pay angel tax to the Income Tax Department.

What is the applicability of angel tax?

You now have to assume that the corporation is subject to taxes on all of its funds. This is untrue, though. Only the premium amount that the business receives is subject to taxation. Put simply, the determined amount is subject to taxation at the appropriate rate. This is the difference between the face value of the issued shares and their real worth.

Angel tax example

The angel tax India poses significant challenges for entrepreneurs as they must repay a substantial portion of their investment through taxes. To illustrate, consider a scenario where a company raises Rs 50 crore in funding by selling 1 lakh shares at Rs 5000 each to an Indian investor. Although the fair market value of each share is Rs 2000, the fair market value of the shares is likely to be Rs 20 crore. Consequently, the company must pay Rs 30 crore (Rs 50 crore – Rs 20 crore) in angel tax on the excess of fair market value. This transaction would result in a tax liability of Rs 9.27 Crore (30.9% of Rs 30 Crore).

Why is the startup community opposing angel tax?

Angel tax India implications depend on the company’s fair market value. It has been a point of controversy for both the income tax agency and entrepreneurs. The tax department determines market value using the company’s net assets and the rule book. Nonetheless, the startup’s anticipated development prospects and future estimates based on these prospects play a significant role. It aids in figuring out the startup’s fair market value. 

A discrepancy in the technique used to determine the startup’s market worth; it must pay a 30% angel tax. Angel taxes hamper a startup’s development prospects. It substantially degrades its viability by erasing a significant chunk of its investible surplus.

There has been a prolonged commotion from the startup community over the introduction of angel tax. So, the government has now guaranteed the entrepreneurs that none can use the coercive action to collect angel tax. It has also formed a committee to look into the problem.

Final words

The idea of angel tax has drawn much criticism, even with the angel tax exemption granted to investors and companies. Angel tax impositions have stunted the expansion of several Indian firms. Various regulation adjustments are necessary in this area to encourage young people to work in the startup industry.

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